What is Days Payable Outstanding (DPO)?
Days payable outstanding (DPO) is a ratio that measures the average time taken by a business to pay its suppliers or creditors. For example, if a company’s DPO ratio is 28, it means that the company pays its suppliers after 28 days.
Usually, a higher value means the company keeps the funds longer and is slow to pay back its liabilities. However, the ratio may vary depending on the industry and its payment customs. Additionally, a company with a higher value is more flexible in utilizing the funds for its working capital and investment purposes.
Table of contents
- What is DPO?
- What does it mean?
- How to Calculate? Examples
- Industry-wise DPO – Examples
- Cash Conversion Cycle
- DPO vs. DSO
- How to improve?
- Advantages and Disadvantages
- Days Payable Outstanding Calculator
- Recommended Articles
- Days payable outstanding is a computation of the average days it takes a business to settle its payables.
- To calculate the DPO, multiply the specific period by accounts payables and divide the outcome by the cost of sales (COGS)
- If the value is high, it indicates the company has a good funds optimization strategy. In contrast, when the value is lower, the company is not utilizing in-hand capital efficiently.
- While DPO states the period it takes to resolve payables, DSO states the time it takes to collect all receivables.
What Does Days Payable Outstanding Mean?
- Companies buy raw materials, products, etc., on credit. The accounts payable a/c records these pending transactions. It generally tells how much of a supplier’s money is unsettled.
- Apart from the amount, the company also needs to record the date of invoice generation and the bill payment.
- It helps assess the day’s duration between the payables and receivables, giving a generic view of the liquidity. However, the decision-making process does not end with this; it is only one of the methods.
Days Payable Outstanding Formula
The formula to calculate DPO is,
- Accounts Payable: A short-term liability that is yet to be paid.
- Cost of Sales: The sum of all expenses incurred to create a product worth selling. Usually, it includes raw materials, transportation, and rent costs.
- Number of Days: The period over which the DPO is calculated. It could be either weekly, monthly, or annual.
- The calculation varies in terms of days marked for the period; they could be yearly, monthly, or weekly assessments.
- The cost of sales generally includes the direct material, labor, and expenses incurred to make the product ready for sale. However, if there are certain exceptional costs, the calculation must include those and point them out separately.
How to calculate Days Payable Outstanding? – Examples
Company A has an outstanding payable of $25,000, and the cost of sales in producing the product is $65,000. Calculate the days payable outstanding on a monthly basis (Days = 30).
DPO is 12. It takes the company 12 days to fulfill pending invoices.
Company B has an account payable at the yearend of $33,500. The direct costs are as follows:
- Cost of Direct Material = $170,000;
- Cost of Direct Labor = $95,000;
- Cost of Direct Expenses = $42,000;
Calculate the days payable outstanding on an annual basis (Days = 365).
First, we take a sum of all the costs to compute the cost of sales.
Now, we calculate DPO.
DPO is 40. It takes the company 40 days to fulfill pending invoices.
Company C has the following list of creditors,
- Amount due to Creditor X = $12,000
- Amount due to Creditor Y = $9,500
- Amount due to Creditor Z = $18,000
The cost of sales during the year is $130,000. Calculate the days payable outstanding for the year (Days = 365).
First, we take a sum of all liable expenses to compute the accounts payable.
Now, we calculate DPO.
DPO is 111. It takes the company 111 days to fulfill pending invoices.
Days Payable Outstanding – Interpretation
To interpret the DPO, the companies should compare it with the industry average, similar companies’ DPO, and also its DSO and DIO. It provides an idea if the company has a low or a high value. Hence, it will be easier to interpret.
- It is advantageous as it provides additional time to optimize available capital.
- It can, however, become a limitation if the payments are delayed too much and too often. As it may lead to the loss of suppliers and vendors and an unfavorable business image.
- On the other hand, an extremely high value can depict a lack of creditor funds. It indicates that the company has a low inflow and, thus, fewer funds.
- It can be unsuitable if its inflow and outflow don’t match. The company should make sure its cash inflow (cash from customers) is in line with outflow (money to vendors)
- It suggests that the company’s strategies to utilize funds are unsatisfactory. It is not optimizing the available finances resourcefully.
- It can also depict that the company’s relationship with its creditors is not optimum. It may only have arrangements for short-term payments.
Industry-wise DPO – Examples
IT Industry Examples
Automobile Industry Examples
Airline Industry Examples
DPO and Cash Conversion Cycle
- The cash conversion cycle calculates a company’s total days to convert inventory costs into sales cash flow. It uses metrics like the DPO (Days payable outstanding), DSO (Days sales outstanding), and DIO (Days inventory outstanding) to determine the cycle.
- The whole conversion cycle starts with inventory to sales metric DIO. After which, we determine cash inflow through DSO (money from customers). In the end, we gauge the cash outflow using DPO.
- The formula is,
Cash Conversion Cycle = DIO + DSO – DPO
Company ABC has the following data,
- DSO = 45
- DIO = 32
- DPO = 50
Cash conversion cycle = DIO + DSO – DPO
= 32 + 45 – 50 = 77 – 50 = 27 days
Company XYZ wants to calculate its cash conversion cycle. The financial metrics for the last year have been,
- Accounts Payable = $45,000
- Accounts Receivable = $25,000
- Inventory = $40,000
- Cost of Sales = $75,000
- Credit Sales = $95,000
- Number of Days = 365 days
The formulas are,
DIO = (Inventory / Cost of Sales) * Number of Days
DSO = (Accounts Receivable / Credit Sales) * Number of Days
DPO = (Accounts Payable * Number of Days) / Cost of Sales
DIO = (40,000 / 75000) * 365 = 194.67
DSO = (25,000 / 95,000) * 365 = 96.05
DPO = (45,000 * 365) / 75,000 = 219
Cash Conversion Cycle = DIO + DSO – DPO = 194.67 + 96.05 – 219 = 71.72
Company XYZ takes 71.72 days to convert inventory to cash flow.
DPO vs. DSO
- It represents the cash outflow of a company
- It shows how often a business makes payments to the suppliers
- The high ratio value is considerably good, as the company has in-hand capital to invest in short-term
- It uses accounts payable to calculate the ratio.
- Days sales outstanding (DSO) depicts the company’s cash inflow
- It shows how many days it takes a business to receive payments from its customers
- A low value is better as it signifies that the customers are fast to pay all their pending invoices
- Accounts receivable is the primary metric this ratio is based on.
How to Improve Days Payable Outstanding?
Various factors affect DPO and can lead to its improvement.
- The company needs to align its short and long-term goals with the credit sale and purchasing. Once they coincide, the company can optimize and improve DPO.
- Every company can delay the payment to an extent. Paying right before the absolute payment date gives the company extra access to the capital.
- Choosing suitable suppliers is also an important aspect. The company should select vendors that provide longer durations, affordable pricing and agree on flexible terms.
- The company should always be in check with industry standards. Regularly compare the terms on an industry level and make changes if necessary.
- Having an up-to-date technology-equipped invoice processing system can be beneficial.
Advantages and Disadvantages
- It enables businesses to ensure timeliness between payments from debtors and to creditors. This schedule plan can optimize in-hand funds utilization.
- It helps compare the terms of various debtors and creditors involving newer applications to see if they fall within the ambit of the plan.
- The entity could compare its own DPO with the industry standards to check if they are ahead, on track, or falling behind. It will be helpful while taking corrective measures and actions.
- It is not an accurate measurement of the efficiency of funds utilization
- The lack of duration optimization can be due to industry, season, or market-specific issues. Under those circumstances, no need to take this into account
- It may enable the management to utilize the funds better. However, the entity can’t do much since the terms of the creditors and debtors are fixed and not amenable.
Entities in the trading business extensively use DPO. The formula is to multiply the payable accounts by the number of days and divide the result by the sales costs. It is insightful to the trade cycle and into the general market trend. The control over the deviation of this ratio is helpful for variation analysis over multiple periods.
Days Payable Outstanding Calculator
Use the following calculator for DPO calculations.
|Days Payable Outstanding =||(Accounts Payable x Number of Days) / Cost of Sales|
|=||0 x 0 / 0 = 0|
1. What is days payable outstanding ratio? Is it good at high or low?
Answer: Days payable outstanding (DPO) measures the total days a company takes to clear all accounts payable payments. One can calculate it as the multiplication of accounts payable and total days and then divide it by total costs. A higher ratio signifies a good fund strategy in place. However, it should be too high as it can lead to bad supplier relationships.
2. What is days payable outstanding for a service company?
Answer: In the case of service companies, where no inventories exist, the only costs are wages. Here, the cost of sales only includes direct costs.
3. Can days payable outstanding be negative?
Answer: It cannot be negative. As it denotes the days a business takes to fulfill supplier invoices, it can only start from positive numbers.
4. How long can accounts payable be outstanding?
Answer: Generally, these periods differ due to businesses, vendors, and payable terms. However, the minimum period for DPO is 30 days (a month), lasting upto a maximum of 365 days (a year). Most businesses prefer not to cross this limit.
5. How to reduce days payable outstanding?
Answer: To reduce the DPO ratio, a company can make quick or earlier payments to their suppliers. They may need to optimize their funds and make needed arrangements. One solution can be to collect receivables sooner than before and reduce short-term investments.
This is a guide to Days Payable Outstanding. Here we discuss its meaning, formulas, calculations, and the difference between DSO and DPO. We give you the excel template and outline the advantages and disadvantages. You can also go through suggested articles to learn more,